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Small could be big in digital music

Working in the media and entertainment group of the consulting firm McKinsey & Co., Greg Scholl got a firsthand look at the inefficiencies in the music business: The major record labels focus on creating hits, and they rarely make money on releases that sell less than a few hundred thousand copies.

Now, as chief executive of The Orchard, a music distributor that sells to iTunes, Napster, Yahoo and other major digital music services, Scholl is trying to exploit those same inefficiencies.

The Orchard believes it can make money buying up music from small independent and foreign labels, then distributing it to digital music services.

In most music stores, of course, CDs of Kenyan or Chinese music would be consigned to the world music bin as a good-will gesture. But the economics of online stores is changing the financial calculations of the music business, making it profitable to sell a relatively small number of copies of a song, as long as a CD is not manufactured and distributed.

So instead of trying to sell millions of copies of hundreds of albums (the standard music industry strategy), The Orchard hopes to sell hundreds of copies of thousands of albums. In that way, the company is anticipating that sales will follow a pattern known as "the long tail," in which a large number of relatively unpopular items can produce significant revenue over time.

"We're not trying to make something a hit in order to make a business work," Scholl said. "We cast a very wide net and we're going to catch some hits in it."

So far, The Orchard has made deals to sell about 650,000 tracks (about 30,000 albums' worth of music) from 72 countries to various services, including ring-tone outlets. Those tracks include some music from well-known bands like Black Uhuru and the groups on the punk label SST, as well as thousands of Chinese pop songs. Much of that music is not yet online, and the company is not sure if all of it will ever be. The plan is to add music to various services gradually, so it can be promoted appropriately.

The Orchard is not the only company looking to mine gold in some of the more obscure parts of the music business. One of The Orchard's rivals, the Independent Online Distribution Alliance, or IODA, recently got the rights to digitally distribute 60,000 albums' worth of music from the Chinese state-owned record company. The Orchard also faces competition from the independent distribution companies owned by major labels.

The wager these executives are making is that the nature of online services will increase demand for music that was previously unpopular, just as eBay stoked the sale of old books and trinkets once thought to be worthless.

"In the world of shiny, plastic discs there are two barriers to getting the music you want: It's not in the store, or you've never heard of it," said Ted Schadler, an analyst at Forrester Research. "With digital distribution, the first barrier disappears. The second gets eased because of search engines, recommendation engines, technology like that."

The Orchard was founded in 1997 as a CD distribution company by Scott Cohen and Richard Gottehrer, a songwriter whose hits included "My Boyfriend's Back" and "I Want Candy." (For a company so interested in the world, it was named after its original location: Orchard Street in Manhattan.) But it began losing money and eventually acquired a reputation for being less than prompt with payments.

In 2003 The Orchard was bought by Dimensional Associates, the private equity arm of JDS Capital Management, for what Scholl indicated was less than $10 million. Dimensional also owns the online service e-music and a music publishing company, and was interested in The Orchard partly because of the digital distribution rights it had acquired.

"We were aware of the reputation and we worked to pay everyone back and begin more transparent accounting," said Scholl, who was brought in to run the company.

The Orchard, as Scholl puts it, is a "digital aggregator," a middleman between small independent labels and digital music services. Major labels, as well as most sizable independents, deal with such services directly or through an established physical distribution company such as the Alternative Distribution Alliance, which is owned by Warner Music.

The Orchard and IODA mostly represent small labels but in large quantity. Along with a smattering of tracks recorded by stars before they signed with major labels, they offer what might be called an embarrassment of niches: free jazz, black metal and, in the case of The Orchard, a label that specializes in calliope music. Since the cost of putting tracks online is low, anything that could sell a few copies is worthwhile.

"I'd say we more or less want everything," joked Kevin Arnold, founder and chief executive of IODA.

Most digital distribution deals give the distributor 15 percent of the wholesale price of a track, usually somewhere around 65 cents, according to several people familiar with them. Scholl said that The Orchard generally receives a higher percentage because it is able to effectively promote music to the services that sell it. To generate attention for some of the music from China, for example, The Orchard arranged for Jackie Chan to give the service a list of his favorite tracks.

"It's the equivalent of taking the music from the back room, where you'd have to look for it, into the store," said Scholl.

For some of The Orchard's international partners, the strategy is working.

Epsa, an Argentine tango label, distributes about 500 albums through The Orchard. Laura Tesoriero, the label's chief executive, who also works with The Orchard as a representative in South America, said the label had sold 10,000 digital tracks last quarter, enough to make her encouraged about the future of digital sales. A significant number of those sales, she believes, were to Argentines living in the United States.

The most significant growth in sales of foreign music could come as the idea of buying online gains traction among various ethnic communities in the United States.

Even with a business model that does not rely on hits, that would certainly be welcome.

"One man's niche is another man's mass market," said Mike McGuire, an analyst at Gartner Group.